Earlier this year, SEBI permitted the trading of cross currency pairs on the stock exchanges. Cross currency pairs are basically pairs of currency in which the Indian Rupee (INR) is not involved. So you can have cross currency pairs between Dollar/Euro, Dollar/Pound and Dollar/Yen etc. Let us first understand how a currency pair is traded on the stock exchanges.
Currency pairs with INR: How are they traded?
Currency pairs are normally traded between a hard global currency like the US dollar, UK Pound, Euro or Yen and the INR on the other side. The currency futures of the USD-INR pair is expressed in terms of the value of 1$ (base currency) in INR (quote currency) terms. So if the current exchange rate is Rs.67.50/$ then the USD-INR currency pair can be purchased or sold at Rs.67.50. When do you buy a currency pair and when do you sell a currency pair? Here the Dollar is the base currency and it is expressed in terms of INR. Therefore, if you are expecting the US Dollar to strengthen vis-à-vis the Indian rupee then you can buy the USD-INR pair. The same logic will apply if you are expecting the INR to weaken. On the other hand, if you are expecting the dollar to weaken vis-à-vis the INR, then you will sell the USD-INR pair. The same logic applies if you expect the INR to strengthen.
Who typically buys the USD-INR pair and who sells them? The importer of goods needs to hedge against a strengthening dollar. The foreign currency borrower will also have to hedge against a strengthening dollar. They will, therefore, buy the USD-INR pair to hedge their risk. On the other hand, an exporter wants to hedge against weakening dollar so they will sell the USD-INR pair to hedge against weakening dollar. The USD-INR pair trades in minimum lot sizes of $1000. Similarly the Euro pair and the Pond pair also trade in lot sizes of €1000 and £1000 respectively.
Cross Currency Pairs: How is trading structured?
Cross currency pairs are currently available on 3 currencies viz. the USD versus the Pound, Euro and the Yen. In any pair, including the cross currency pair, the first currency is the base currency and the second currency is the quote currency. What it means is that the first currency will be quoted in terms of the quote currency. Look at the table below for the cross currency pairs available:
All the cross currency pairs are quoted in 1000 units of the base currency in the above cases.
Who will be using cross currency pairs? Let us take the example of an India company which imports from Germany and then exports to the US. This company will have exposure to the US Dollar and to the Euro. Since the company is importing from Germany it will have to protect against strengthening Euro. So it will have to buy a EURINR pair. At the same time, since the company is exporting to the US it will have to protect against a weakening dollar. So it will have to sell the USDINR pair. An easier way would be to just buy the EURUSD cross currency pair. The company is automatically hedged against a strengthening Euro and also against a weakening US dollar. That is the utility of cross currency pairs.
Cross Currency Options
The cross currency options will have a European style expiry, which means it can only be exercised on the date of expiry. The premium will be quoted in the quote currency i.e. in case of EURUSD pair; the option premium will be quoted in USD. There will be 3 monthly cycles and 3 quarterly cycles with a total of 12 ITM strikes, 12 OTM strikes and 1ATM strike available to trade. Like in case of other currency options, the cross currency options will also expire at 12.30 pm, two days prior to the last trade date and will be settled at the final settlement price.
Cross currency futures and options are a new instrument of trading wherein currency traders can simultaneously take a view on two currencies at lower costs.
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